Understanding Prime Rate and How it Impacts your Savings

| July 19, 2013

savealittlemoney (2)Economics can be a tough thing to figure out, especial to the lay person. How do things like the Fed, the interest rate for banks, the prime rate affect you, or even mean? It can be hard to make any sort of sense out of all this at all! We’ll here we plan to look at the basics of this and how it can affect your savings, how it relates to you, without bogging you down in technical speak and math. Some math is unavoidable but it will be simple and easy to understand.

The Fed

The Fed is the Federal Reserve, this a private bank that prints and lend the government money, as well as sets the Federal Funds Rate, and the Discount Rate. They do not set the Prime rate however.  So why care about the Fed or these other two rates? Because most banks follow these,  this is the rate that the bank gets to borrow money on, a change in the banks expenses means a change in how much they can afford to pay your savings interest. So while the Fed does not directly affect the Prime rate it plays an important role in determining the Prime Rate and how banks pay interest.

The Prime Rate

So now we know about the Fed, and the rates that it sets. The Prime Rate is the lowest interest rate a bank will charge on a loan. This will vary from bank to bank meaning that the Prime Rate can change a little depending on the bank. Since banks pay interest for their money from the Federal Funds Rate, the Prime Rate is calculated from it. The general rule of thumb is that you add 3% to the Federal Funds to get the approximate nationwide Prime Rate.

Your Savings

So far so good but we still haven’t talked about how this actually affects you, what does this mean for a savings account, a college or retirement fund? Well because this is the lowest rate at which banks can make money it can affect how much interest they pay on investments as well since the Prime Rate is how banks estimate profits. What this means is if you have a short term but fairly safe investment savings the Prime Rate going down will slightly lower how much you get in your returns, but no really touch your savings.

If you are in a long term investment a similar rate cute will actually end up increasing the value of your original investment. In general what this means is that a rate cut makes it cheaper for banks to lend and borrow money, thus they can charge less interest to customers, but also means they make less so short term investments drop, but long term ones see benefit as more are able to invest. A rate hike means it is harder for the banks to lend and borrow from the Fed, so they charge higher interest rates themselves, increasing short term profit, but enabling less people to use the bank and hurts long term investors.

This is Written by Jay a finance writer from comparepaydayloans.co.uk.

Tags: , , , , , ,

Category: Banking

Comments are closed.